IRS chief: First steps to narrow $300B tax gap

NEW YORK (CNNMoney.com) -- The $290-billion tax gap is getting a lot of attention as a magical windfall for government budget woes. The problem: Getting the amount owed in taxes each year but not collected isn't so easy.

From IRS Commissioner Mark Everson's perspective, you've got to start somewhere. At a House subcommittee hearing on Tuesday, Everson characterized the Bush administration's 16 proposals to narrow the gap as "an important start."

The 16 proposals, which are included in the president's fiscal year 2008 budget, have been criticized as insufficient and lacking "energy," since they're estimated to raise tax revenue by $2.9 billion a year, or just 1 percent of the estimated gap.

Everson singled out some of Bush's proposals that he thought especially critical to implement. Among them:

Require banks to report merchants' annual credit card reimbursements.

Boost reporting on investments by brokerages and other third parties.

Make willful failure to file a tax return repeatedly a felony instead of a misdemeanor.

Underreporting of income accounts for 80 percent of the tax gap, of which half is due to underreporting of net business income by individuals. Another 18 percent of the gap is due to failure to file among other things.

"Where there's third-party reporting and withholding you get much better compliance," Everson said.

He noted that the noncompliance rate among taxpayers whose wages are reported by an employer is just 1 percent. But among small business owners, those with investment income and others with income that is not reported by a third party, noncompliance rises to 50 percent. In terms of investment income, under current law, capital gains reporting is hard to verify since brokers don't need to report the cost basis for sales to the IRS.

Another group found to have owed but not paid back taxes in recent years is government contractors working for federal agencies that didn't participate in the IRS's Federal Payment Levy Program. The levy program can withhold all or part of a government contractor's payments if the contractor has tax debts.

In the most recent example, more than 20,000 Medicare doctors and suppliers receiving Medicare payments in the first nine months of 2005, for instance, were found to owe $1.3 billion in back taxes, according to a recent Government Accountability Office (GAO) study.

Confusion over a complex tax code certainly plays a part in the underreporting of income, Everson said, but so does willful noncompliance.

Besides boosting compliance and enforcement efforts to help narrow the tax gap, the IRS despite heavy criticism started using private debt collection agencies, about which members of the House Ways and Means oversight subcommittee grilled Everson, especially the new program's cost.

Rep. Bill Pascrell (D-NJ) noted that it costs the IRS 25 percent of every dollar the private agencies collect, whereas it only costs less than half a percent for every $100 an IRS auditor collects.

"I have consistently stated that the IRS could do this cheaper," Everson said. But, he contended, the IRS doesn't have sufficient enforcement personnel to deal with all its collection cases. Over the past several years the agency has lost about a quarter of its enforcement staff and is ramping up again but, Everson told lawmakers, "even if you threw money at us" it would take several years before there was adequate staff trained to address all the potential collection work. "With debt, the longer you wait the harder it is to get."

In her annual report to Congress National Taxpayer Advocate Nina Olson listed the use of private debt collectors as one of the most serious taxpayer problems, noting that the IRS has "thousands of collection employees. In contrast, PCAs(private collection agencies) at this stage of the initiative are using 75 employees to collect on these accounts, and the IRS is using 65 employees to monitor them."

In addition, she wrote, a high number of complex cases have been assigned to private companies, instead of the less complex ones that they were originally intended to get.

Since the IRS started using private collection agencies (PCAs) in September 2006, 30,000 cases have been outsourced and the PCAs have brought in roughly $12 million in gross revenue. In his testimony before the House Budget Committee in February, Everson said the IRS estimates the PCAs will generate gross revenue of $1.4 billion by 2017.